CNP Assurances: Tier 3 open for business

CNP Assurances launched the first Tier 3 transaction under Solvency II in the euro market on 12 October. Here, Jean-Philippe Médecin, director for ALM and funding, and Stéphane Trarieux, funding department, at the French insurer explain how the new instrument fits into its capital stack and the implications for investors, as well as the execution of the landmark deal.

What was the rationale for issuing a Tier 3 transaction?

Jean-Philippe Médecin, CNP: As for most European insurers, subordinated debt is a key element in our financial structure. The Tier 2 instrument has hitherto been widely used by issuers in the sector, and well known in the market. Under Solvency II, Tier 1 and Tier 3 instruments had barely been used, at least not in a major currency.

However, we considered that the Tier 3 format offered a lot of advantages and allowed us to better optimize our capital structure: firstly, it is fully eligible for regulatory capital requirements, as long as it respects the limits; secondly, it includes terms that are more investor-friendly than Tier 2 instruments, which makes tighter pricing possible. At the end of the day, the specific features we chose, notably a six year bullet maturity, allowed us to reach new accounts.

What are the pros and cons for an issuer relative to other instruments?

Stéphane Trarieux, CNP: As we mentioned, a Tier 3 structure offers a number of benefits, especially for issuers who currently have a large bucket not used by DTAs (deferred tax assets).

The only drawback of this instrument is that it is ineligible for Total Adjusted Capital (TAC) in Standard & Poor’s methodology. We considered that CNP Assurances already had a high level of TAC for its current rating and that the cost-saving compared to an S&P-eligible bond was significant enough to justify our choice.

Were there any specific challenge in the structuring of this new instrument?

Médecin, CNP: Even though there were no Tier 3 precedents in the euro market, we did not encounter any major difficulties in structuring the instrument. The only point of discussion concerned its rank in the hierarchy of debt. Indeed, the old Tier 2 bonds we issued until 2014 did not allow the appearance of a new class of “senior subordinated” instrument ranking between senior unsecured and Tier 2 instruments. At the same time, we had the feeling that a ranking senior to Tier 2 could improve the pricing on our side. So we opted for a dynamic subordination rank that we clearly specified in the prospectus: as long as old instruments are still outstanding, Tier 3 instruments will be considered as “ordinary subordinated”; thereafter they will become “senior subordinated”.

Could you explain why this instrument is considered the most investor-friendly insurance structure?

Trarieux, CNP: Out of the types of insurance subordinated debt, Tier 3 is the least risky instrument for investors. Indeed, there is neither optional coupon deferral, nor the possibility of deferral at the discretion of the regulator in the absence of a trigger being reached. Ultimately, coupon deferral may only occur in the event of a breach of the Minimum Capital Requirement (MCR) — a very remote scenario. In our case, as of 30 June 2016, the distance to this trigger was Eu12bn (equivalent to a MCR coverage ratio of 280%). That can be compared to a distance to the SCR of Eu8.5bn for the Tier 2 issues. It is clear that in both cases we are far from the triggers, but even more so for the Tier 3. Finally, the six year maturity of our new Tier 3 issue represents a very low risk of extension, since the structure is not a 30NC10 like most of the Tier 2 issues.

How did you go about preparing the transaction and approaching the market?

Médecin, CNP (pictured, right): We have had the idea of issuing a Tier 3 instrument in mind for quite a long time. Nevertheless, we had to wait for Solvency II to come into force (1 January 2016) and to take into account the various constraints that every issuer faces.

Once the decision was taken, we validated with our bookrunners the strategy for approaching the market, which included a marketing phase a little more developed than for a Tier 2, though reduced in time to limit our exposure to market developments.

Why did you conduct some one-on-one investor calls?

Trarieux, CNP (pictured, left): CNP Assurances is a well-known name among investors, thanks to our regular roadshows and presence on the screens. We considered that the marketing of the new structure was the crux of the matter at least as much as explaining the group’s latest developments. By carrying out many one-to-one investor calls over a limited period of time we were able to thoroughly explain the structure. Anyway, around two-thirds of the questions were related to the characteristics and the position of this instrument in our financing structure. A physical roadshow would probably not have been as efficient in this context, but we will of course keep organizing non-deal roadshows. The success of the transaction leads us to think that the one-and-a-half-day’s of marketing through these investor calls allowed us to arouse the interest of and convince investors.

How do you go about pricing such a new instrument?

Médecin, CNP: You can imagine that, with no comparables on the euro market, the price discovery angle was prominent in this project. Two approaches were possible: starting from senior debt and adding the premium for the subordination and the deferral clause; or starting from a Tier 2 instrument and removing the spread linked to the less investor-friendly features. The two approaches ultimately arrived at results that were not so far apart, with a landing point around 200bp, new issue premium included. At the end of the day, the Tier 3 instrument came out at very competitive levels versus a Tier 2 instrument, and our goal was fulfilled.

What was the response from investors like?

Trarieux, CNP: Investors were very interested in the new structure. They recognised the relevance of the instrument for both CNP and their bond portfolios. Their views on the pricing differed, but they almost all validated the final level by maintaining or even increasing their orders.

Was the level of demand in line with your expectations?

Médecin, CNP: We were expecting a strong demand on this relatively low-duration subordinated instrument because of the wider conditions on the credit markets: we were offering an attractive yield in a market distorted by the CSPP (Corporate Sector Purchase Programme). We were not worried about the reception this instrument would get, and price discovery was ultimately very satisfactory for us.

Was the distribution in line with your previous transactions? Did you see any new investors thanks to the bullet format?

Trarieux, CNP: We found that among the 335 investors, most were accounts we already knew. The trickiest part to estimate is the presence of specific funds of well-known asset managers that usually do not take part in 30NC10 issuance because of their mandate. We think that this was the case, but without necessarily being able to quantify it.

Did you achieve your objectives?

Médecin, CNP: Our main goals were the following: taking advantage of the new Solvency II regulation that allows Tier 3 subordinated debt as the cheapest form of regulatory capital; reducing the average cost of outstanding subordinated debt; partially fulfilling the Tier 3 regulatory bucket, which, unlike other insurance companies, is empty because of the absence of net deferred tax asset (DTA); and diversifying the investor base by issuing a more investor-friendly structure than the usual 30NC10 Tier 2 bond. We consider that they were all fulfilled.

Do you expect to continue to be active in this format? Do you have any other capital issuance plans you can outline?

Trarieux, CNP: We think that Tier 2 will remain the most used instrument in the sector because it is the one with the greatest capacity for issuance under Solvency II. We see Tier 3 as an opportunistic complement, but in limited amounts due to the bucket size and its variability. In the future, CNP should of course remain active in the bond market, with a well-established curve.